Building Wealth: Do you Pay Yourself First?

If you’ve spent any amount of time on Personal Finance or money blogs, you will know that ‘Pay Yourself First‘ is the first mantra that they teach you. Of all wealth-building strategies, this is the most-often repeated.

But do you know the funny part?

From among the ‘money men’ I know personally, very few people actually follow this advice. These are financial planners, Chartered Accountants, businessmen – people you would think know a bit about handling money.

So I had to ask the question. Why?

First of all, what is paying yourself first?

Wealth building, some people have said, is like losing weight. Everyone knows that to lose weight, you must expend more energy than you consume. It is as simple and as hard as that. To be able to build wealth, you must spend less than you earn. From every pay check you receive, you must save a percentage and spend what is remaining. Many of us push saving back to the end of the month, after we have exhausted all our spending, and too often we find that we have nothing.

The philosophy behind paying yourself first is simply that: before you pay anybody else in your life with your money, you pay yourself.

In the classic personal finance book, The Richest Man in Babylon, we meet Arkad, the wealthy merchant, imparting some financial wisdom to a group of Babylonians.

For every ten coins thou placest within thy purse take out for use but nine. Thy purse will start to fatten at once and its increasing weight will feel good in thy hand and bring satisfaction to thy soul.

“Deride not what I say because of its simplicity. Truth is always simple. I told thee I would tell how I built my fortune. This was my beginning. I, too, carried a lean purse and cursed it because there was naught within to satisfy my desires. But when I began to take out from my purse but nine parts of ten I put in, it began to fatten. So will thine.

“Now I will tell a strange truth, the reason for which I know not. When I ceased to pay out more than nine-tenths of my earnings, I managed to get along just as well. I was not shorter than before. Also, ere long, did coins come to me more easily than before. Surely it is a law of the Gods that unto him who keepeth and spendeth not a certain part of all his earnings, shall gold come more easily. Likewise, him whose purse is empty does gold avoid.

“Which desirest thou the most? Is it the gratification of thy desires of each day, a jewel, a bit of finery, better raiment, more food; things quickly gone and forgotten? Or is it substantial belongings, gold, lands, herds, merchandise, income-bringing investments? The coins thou takest from thy purse bring the first. The coins thou leavest within it will bring the latter.

The idea is simple

Before you do anything with your pay that comes in every month, take a percentage (at least 10%) of it and pay yourself with it.

Trick yourself into believing that you must make do with whatever is left.

If you make a habit out of it, you will not miss the 10% that you’ve put aside.

The slowly accumulating corpus that you pay yourself with every month will give you joy and comfort.

But why don’t we follow it?

I think there are two reasons for this. One, we don’t think that wealth building could rest on such a simple strategy. We think that there must be something more to it, some secret that we’re missing. Could it really be as simple as this?

The other, more dangerous reason is that as our savings corpus builds and swells, so does the temptation to spend it. If we keep up the habit of paying ourselves with 10% of our incomes for a year, we will have a whole month’s salary staring back at us from our bank accounts. How do we then kill the temptation monster?

After a few failed attempts, this is what my wife and I do now.

We have a recurring deposit that automatically deducts a certain amount of money from our savings account at the beginning of every month. (This arrangement has changed a little now that we’re both self-employed, but it worked beautifully when we had regular paychecks.)

At the end of the year, when the deposit matures, it goes directly into one of our investment vehicles. We don’t even ask the question of whether we can spend it. As far as we’re concerned, the money doesn’t exist.

They say that a ‘system’ works better than a goal. An automated system works better than a manual system. By setting up an automatic debit transfer from our savings accounts every month, we’re doing two things: one, we’re taking the emotion out of it, and two, we’re planning and budgeting with the ‘remaining’ amount in mind. So we’re never surprised.

If you’d like to set up a recurring deposit of your own, talk to your bank. Almost every bank in India today lets you do this through their online portal. It took me no more than a few minutes to set up mine.

Has it helped us?

Enormously. It’s not just the fact that you ‘feel’ wealthy, because your recurring deposit accounts keep growing with time, but we found that we were sleeping a lot better. We loved the habit so much that even today, though our pay checks are erratic, whenever money comes into our accounts, the first thing we do is transfer a percentage of it into a deposit.

What is the biggest plus of doing this?

Security. We know that we’re protected to a degree against outside forces. An emergency of any kind can occur, but at least we’re not going to be found wanting on the financial side. If we were to lose our earning potential, we can rely on our saved corpus to tide us over.

We’re emotionally much stronger. We feel much safer. We’re more frugal. Though we sometimes wonder if we’re being miserly, most of the time we’re happy with our choices.

Is it worth the movies, the restaurants, the trips that we’ve missed in order to build this corpus? Unequivocally I would say yes.

What is a good ‘pay yourself’ percentage?

Throughout my working life I have stuck to 33%.

My reasoning is simple. On an average, you spend a third of your life in education, a third working, and a third in retirement. So even assuming that you’re debt free at the beginning of your working life, you have to save a third of your income from the beginning.

As it turns out, investing wisely and using compound interest to your advantage means that the percentage could be much lower. In fact, many people I’ve spoken to say 33% is way too high.

But it works for me. I save the first third, I pay my bills with the second third, and I spend the third third.

But we’re still young. We’re yet to start a family. I fully expect this percentage to drop as the years roll on. Depending on where you are in your life, you should pick a saving percentage that you’re comfortable with.

It’s better to go for a lower percentage and stick to it consistently rather than be ambitious and give up in a couple of months.

However, listen to Arkad. May you never pay yourself less than 10%.

No excuses.

What about you?

What are some of the practical problems that you face when trying to save money? Have you tried paying yourself first? Has it worked for you? What are some strategies that you practice to overcome your temptation to spend, especially when your savings have grown to a significant amount?

Comments

Truth is always simple. And yes, I saved right from the day I received my first pay check and that’s why I could buy a flat before some of my friends who have better pay checks than me. Today most of my salary is going into the EMI but I am on the verge of clearing all my debts outside my home loan(taken during the process of buying my flat). And in another two months I will be going into positive balance. And I save almost as much amount as I spend to survive. Ofcourse, today I am single and that is possible. But I always spend after saving and not vice-versa. Simple but it works!

Financial discipline, just like any other discipline takes quite a bit of will, motivation and integrity to stick with for more than quite a while. What with youngsters today falling for the lure of advertising and ending up spending their money on relatively fleeting pleasures such as smartphones, gadgets, and other consumables.

As for me and my wife, we too believe in the ‘pay yourself’ funda similar to you. We have separate accounts into which the money goes and stays there ‘forever’. We ended up purchasing a flat, albeit in a Tier III town, with just the money without opting for a home loan with our savings, using this funda. I can therefore unequivocally vouch for the fact that this works, and works well.

Thanks for the comment! It’s almost counter-intuitive that as little as 10% of one’s income can make a big difference at the end, but it really does. Not only because small amounts add up quickly, but also because the saved amount starts accumulating interest almost immediately, and that adds up too.

I think you only get the real hang of it once you’ve tried it and seen it working. Thanks for sharing your story too. My wife and I will try and emulate you guys for as long as we can 🙂